The Gift-Card Economy

What do a gym membership, a bottle of prescription pills and a holiday gift card have in common? Each of them is a thing that is bought and then often goes unused.

In their recent paper “Paying Not to Go to the Gym,” the economists Stefano DellaVigna and Ulrike Malmendier showed that people who buy an annual membership to a health club overestimate by more than 70 percent how much they’ll actually use it. Many people, therefore, would be better off buying monthly or daily passes.

The Cochrane Collaboration, an evidence-based health-care research group, recently issued a report about patients who fail to take their medicine. “People who are prescribed self-administered medications,” it began, “typically take less than half the prescribed doses.” While this may be more troubling as a medical issue than a financial one, it is nevertheless true that the medicine cabinets of America are stuffed with billions of dollars of unused prescriptions.

As for gift cards — well, let’s just say there is good reason that they are known within the retail industry as a stored-value product: they store their value very well, and often permanently. The financial-services research firm TowerGroup estimates that of the $80 billion spent on gift cards in 2006, roughly $8 billion will never be redeemed — “a bigger impact on consumers,” Tower notes, “than the combined total of both debit- and credit-card fraud.” A survey by Marketing Workshop Inc. found that only 30 percent of recipients use a gift card within a month of receiving it, while Consumer Reports estimates that 19 percent of the people who received a gift card in 2005 never used it.

Considering that two-thirds of all holiday shoppers in 2006 planned to give someone else a gift card, you most likely received one yourself in recent weeks. Perhaps you are among the exceptional minority, and you have already spent it, or soon will. But the odds say that it has instead wound up in your sock drawer.

Does this mean that a gift card is a bad gift? The answer depends on whom you ask, and it also requires the asking of a separate question: What is gift-giving meant to accomplish in the first place?

An economist might describe a gift as a signaling mechanism that allows one person to tell another person that she: a) is thinking about him; b) cares about him; and c) wants to give him something that he’ll value.

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Illustration by Knickerbocker

Of course there are many different types of recipients and relationships. It’s quite easy to give gifts to people who don’t have the money or the wherewithal to get things for themselves — children, for instance. Since a child can’t drive himself to Toys ‘R’ Us and probably doesn’t have much money of his own, by giving him a toy you are substantially expanding the set of things he has access to. Which makes nearly any gift meaningful.

With adults, it’s a bit trickier. An adult is free to buy whatever he wants, and presumably he knows what he likes. So ideally, you’d want to give him something he might like but doesn’t know about, or some kind of guilty pleasure that he wouldn’t buy for himself. In either case, you are creating value for the recipient by giving him something that is actually worth more to him than the money you spent on it.

But realistically, most of our gifts fall well short of that high standard. This creates a lot of inefficiency. In 1993, the economist Joel Waldfogel addressed this subject in a paper whose continuing fame in economics circles is due in part to its wonderfully Scrooge-ish title: “The Deadweight Loss of Christmas.” Since gifts “may be mismatched with the recipients’ preferences,” Waldfogel argued, it is likely that “the gift will leave the recipient worse off than if she had made her own consumption choice with an equal amount of cash.” He concluded that “holiday gift-giving destroys between 10 percent and a third of the value of gifts.”

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If gift-giving destroys so much value, why not take the most efficient route and simply give cash? Obviously, some people do. In the small survey of Yale undergraduates on which Waldfogel based his paper, grandparents gave cash 42 percent of the time, and parents gave cash 10 percent of the time. But not once did a student receive cash from his or her significant other. Plainly, there are a few relationships for which a cash gift is appropriate, but in most cases, the social taboo crushes the economist’s dream of such a beautifully efficient exchange.

So if cash is inappropriate, and buying gifts is inefficient, wouldn’t a gift card — not quite as fungible as cash but also not nearly as coldhearted — be a perfect solution?

You could certainly make that case. And for the merchant, at least, the gift card is a godsend. Just think of it: In the weeks leading up to Christmas, millions of people visit your store or Web site and hand you billions of dollars in exchange for nothing more than a plastic I.O.U. that may never even be redeemed. Best Buy, for instance, earned $16 million last year in gift-card “breakage,” which is the industry’s term for card value that was bought but never redeemed. Then there’s what retailers call “upspending”: most customers who do use their gift cards spend some of their own money to buy merchandise that is more expensive than the value of the card.

For the giver, meanwhile, a gift card could hardly be easier. But most economists would argue that if a gift card is so transparently good for the giver, it is necessarily bad for the recipient: the fact that it can be bought so easily signals to the recipient that the giver didn’t put much effort into the gift.

In the end, the value of any gift is overwhelmingly dependent on the nature of the relationship between giver and recipient. The economist Alex Tabarrok, writing recently on the Marginal Revolution blog, put an even finer point on this fact, noting that each of us has many “selves,” including a “wild self,” and that “we want the wild self in someone else to be wild about us.” His advice? “If you want to please the economist in me, send me cash. If you want to please my wild self (you know who you are!), use your imagination.”

So next year, if you need a gift for a strict rationalist, consider cash. If you want to appeal to someone’s wild self, you’ll have to use your imagination. And if you’re hoping to send a little something extra to the shareholders of Best Buy or the Gap or Tiffany, consider a gift card.

Stephen J. Dubner and Steven D. Levitt are the authors of “Freakonomics.” More information on the research behind this column is at www.freakonomics.com